Hole in Dunkin' Story?: Greenberg

One of the great lessons I learned back in the ‘90s was when Sequoia Capital, the big venture capital firm behind Cisco Systems , didn’t sell a share on the offering.

Dunkin Donuts
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Dunkin Donuts

Or for years.

Enter Bain Capital, Carlyle Group and Thomas Lee Partners. They can’t seem to get their fill of selling the stock of Dunkin’ Brands, best known for its doughnuts, coffee and Baskin-Robbins ice cream.

They sold a bunch on the IPO in July; a bunch more in November. And after the market closed on Friday Dunkin’ filed that the trio would be selling yet another third of their remaining holdings — leaving them with 37 percent (down from around 90 percent pre-IPO).

And this recent spate of selling came after Dunkin's stock ran up over the past week after the company announced it was initiating a dividend.

I get it that the goal of private equity is to exit, but like venture capital of the old days logically it would appear that if they genuinely believed in the growth they would hang around a little while longer.

With Dunkin’, they’re selling so much so soon you can't help but ask: Why?

Howard Penney of Hedgeye can think of a few possible reasons. From a note to clients Monday he wrote:

"Our view on the longer-term TAIL still stands. Opportunities for the company to grow west of the Mississippi are far less abundant than the bulls believe.

The evidence for our view is as follows: announced new unit openings are lagging actual openings, which is leading to a decline in the backlog of potential new units being opened. Until we are proven wrong by greater disclosure from Dunkin’, we will continue to be bearish on the company’s growth prospects per the announcements of new contracted openings by the company."

He also notes that McDonald’s is launching a breakfast strategy in Dunkin’s stronghold of the Northeast. “McDonald’s is a tough competitor and its new breakfast initiative in the Northeast, including cheese Danishes, muffins, and banana bread, is a signal of intent to take share from Dunkin’ Donuts in its most important region,” he writes.

He adds: “Much of the optimism around the growth story recently was brought about by the recently signed procurement and distribution agreement with a Dunkin’ Donuts franchisee-owned cooperative. Having spoken with our contacts in the Dunkin’ Donuts franchisee community, we believe that the hype may not be matched by reality as time passes.”

The good news at Dunkin’ is same-store sales, which have been strong and in the first quarter may be better than expected.

But, says Penney:

"Most of the research notes that we see on Dunkin’ tend to focus heavily on same-store sales as a key metric for the health of the company. We would agree that comparable restaurant sales growth is an important metric but it is not the most important metric for driving incremental value for shareholders. Since Dunkin’ is a franchised business, its EPS growth is far more leveraged to new unit openings than to comparable restaurant sales. Call us skeptics but we are not encouraged by the company’s lack of disclosure on this issue. Unless we see a dramatic ramp up in announcements of contracted new unit openings, we will retain our current stance."

A Dunkin spokeswoman disagrees. “We have a strong, multi-year domestic development pipeline for Dunkin' Donuts,” she says. “We opened 206 net new Dunkin' restaurants in the U.S. in 2010. We opened 243 net new Dunkin' restaurants domestically in 2011 and have said we intend to open 260 to 280 net new Dunkin' locations domestically in 2012. Globally, we have said we expect to open 550 to 650 net new Dunkin' and Baskin restaurants in 2012.”

Impressive, but Penney is more focused on future announced openings. Dunkin’ discloses openings with an occasional press release. Last year, by Penney’s count, the company announced 145 announced future openings; so far, 23.

Is he right?

I asked Dunkin’ for a quarterly breakdown of the backlog. The spokeswoman implied the company wouldn’t disclose it. “We gave 2012 guidance for Dunkin’ Donuts and Baskin-Robbins domestic comps; net store development for Dunkin’ Donuts and Baskin-Robbins in the U.S. and global; revenue growth; adjusted operating income growth; adjusted operating margin growth; EPS and free cash flow,” she said.

My take: One to continue to watch.

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